Health P.E.I. is cutting all 24 long-term contract doctor's positions, forcing them to choose either a salary position or a fee-for-service option.
The province said it's a tax issue.
The contract doctors haven't been paying the same taxes as other full-time doctors.
Since the contract doctors do the same work, they need to start paying up, said Revenue Canada.
"If contractors are deemed to be employees by Revenue Canada, then Health P.E.I. is obligated to take deductions at source for income tax and CPP," said Dr. Richard Wedge, the department's medical director.
"So if we don't comply with those sort of recommendations from Revenue Canada, we'll be at risk of penalties for not doing it."
Contract doctors have until Aug. 15 to decide whether they want to work for salary or fee-for-service.
It's not clear what impact - if any - the change will have on patients.